For debate in European Standing Committee C, together with the Commission Green Paper on a strategy for energy supply

Background

1.1 As part of the drive to complete the Single
Market, the Council adopted in 1996 Directive 96/92/EC[1]
setting out common rules for the internal market in electricity.
In addition to laying down general rules for the organisation
of the sector, it contained a number of more specific provisions
governing generation, transmission and distribution systems, the
unbundling[2]
and transparency of the accounts of vertically integrated concerns,
and access to the system (where Member States were required to
ensure at least a significant opening of their markets, corresponding
to 30% of domestic consumption in 2000, and 35% in 2003). Two
years later, a comparable measure (Council Directive 98/30/EC)[3]
was adopted for the internal market in natural gas, though the
market access targets were set slightly lower, at 20% in 2000
and 28% in 2003.

1.2 The current documents comprise a Communication
from the Commission which analyses the way in which these two
measures have operated to date. This is accompanied by proposals
for a Directive and Regulation which reflect the findings in the
Communication, with the former amending the rules applying nationally
to access to the supply networks for both electricity and gas,
and the latter laying down further conditions governing the network
for cross-border exchanges of electricity.

The current document

(a) Commission Communication

1.3 In its introduction, the Commission observes
that, because of industry's heavy reliance on electricity and
natural gas, these represent an important share of its production
costs, and that an opening of these markets is a major factor
in improving Europe's competitiveness generally. However, it adds
that the key issue is fair access to the transmission and distribution
grids, which it considers to be more likely if those facilities
are functionally separated from other commercial interests, in
particular generation and supply. The Commission also notes that
the existing Directive offers Member States the choice between
a third party access system based on published tariffs applicable
to all customers ("regulated" access) and one based
on negotiations between parties, with published main commercial
conditions ("negotiated" access); that integrated companies
are required to "unbundle" by separating their accounts;
and that an independent transmission system operator must ensure
non-discrimination between incumbent and new entrant system users.

1.4 As regards the implementation of the Directives
so far, the Commission notes that all Member States have now adopted
the necessary national legislation for electricity, and that most
have also done so for gas (but that, in the latter case, infraction
procedures have been launched against France, Luxembourg and Germany,
which have yet to complete the process). It further notes that
the average degree of opening for the Community as a whole in
2000 was 66% for electricity and 79% for gas (as compared with
the minima of 30% and 20% laid down in the Directives): the UK
was one of the few countries with 100% access in each sector,
whilst a number of countries  notably France  had
achieved little more than the required minima. The Commission
also says that a "clear majority" of Member States have
chosen structural measures most likely to promote effective competition,
particularly for electricity. It therefore concludes that the
current state of implementation is "encouraging", but
that further improvements are necessary. In particular, it considers
that, as things stand, the divergence between the degree of market
opening in the various Member States is likely to continue, and
that this could significantly distort competition within the Community.
Indeed, the Commission goes further, and states that, for real
competition to develop, there is a need for effective unbundling
and fair and non-discriminatory access conditions.

1.5 The Communication then examines a number
of detailed aspects arising in the internal markets, as follows.

 Public service objectives

1.6 The Commission notes that, in the past, these
objectives have in almost all Member States been pursued through
public ownership of all generation and supply functions, but that,
as privatisation and market opening have taken place, governments
have adopted regulatory systems to lay down the minimum standards
of public service which must be provided. These include respecting
environmental standards, guaranteed connection to the grid for
all under reasonable conditions, minimum service criteria for
repairs and connections, uniform tariffs for equivalent customers
(but with special tariffs for low income users), and protection
for vulnerable customers from disconnection. The Commission adds
that the highest possible standard of public service is a primary
objective of Community energy policy, and that the Directives
contain provisions ensuring that Member States retain the necessary
tools to achieve this. However, it also says that experience to
date suggests that universal service and consumer protection have
not only been maintained by market opening, but have increased.

1.7 Notwithstanding this, the Commission believes
that further measures are needed to require Member States to ensure
that public service commitments are met. These include the protection
of vulnerable customers, and connection at appropriate prices
to those in peripheral areas, transparency of information for
all customers, obligation to promote generation from renewable
resources, and suitable levels of infrastructure maintenance and
interconnections. This would be coupled with an obligation on
Member States to notify all the measures taken to the Commission,
which would then produce a bi-annual report.

 Security of supply

1.8 The Commission recalls that its Green Paper
"Towards a European strategy for the security of energy
supply" recognises the contribution made to security
of supply by the integration of energy markets, and also stresses
the importance of security of supply being recognised as an essential
public service obligation. It points out that Directives 96/92
and 98/30 seek to ensure that Member States' safeguards guaranteeing
energy supplies remain unchanged by the introduction of competition,
but it believes that the importance of the issue makes it necessary
to reinforce these safeguards. In particular, it says that Member
States should be required to monitor the existing supply/demand
balance in their domestic electricity market, the level of expected
future demand, envisaged additional capacity planned or in construction,
and the level of competition. Member States would be required
to provide progress reports, enabling the Commission to publish
from time to time a similar Communication covering the Community
as a whole.

 Environmental consequences

1.9 The Commission suggests that the creation
of the internal market has in many respects had a positive environmental
impact, due to improvements in generating plants, increased operational
efficiency, and a switch to cleaner fuels, though it also notes
that lower energy prices might make the development of energy
efficiency and the use of renewables less attractive in future.
It points out that Directives 96/92 and 98/30 allow Member States
to address these issues through public service obligations, and
that many have chosen to do so: in addition, it identifies a number
of initiatives which have been taken at Community level, notably
in the promotion of renewable energy sources, controls over emission
levels from large combustion plants, the promotion of energy efficiency
and energy saving. However, it also stresses that a fully opened
market requires an internalisation of external costs to ensure
a level playing field, and it says that it intends to promote
initiatives to support this, notably a Community-wide energy tax,
strict rules on state aid, and demand-side management measures.

 Effects of competition on employment

1.10 The Commission says that, although the increased
efficiency and lower energy prices arising from the creation of
the internal market will in the longer term boost employment in
European industry as a whole, there is likely in the short term
to be a reduction in the workforce in the energy sector itself,
and that, within this overall trend, there is also likely to be
a shift in the employment balance from the more traditional technical
areas to new business activities, such as marketing and customer
services. It adds that, so far, this has been handled in a responsible
manner, but that the situation needs to be closely monitored,
and additional measures taken, if necessary, to minimise any social
consequences.

 Trade with third countries

1.11 The Commission says that, although there
have in the past been exchanges with third countries, the quantities
involved were relatively limited, due to the low interconnection
capacity between national systems and different operating standards.
It considers that, in a liberalised internal market, trade with
third countries is likely to become more attractive, and is to
be welcomed in principle as increasing competition, provided there
is a level playing field for all economic operators. It therefore
believes that clear legal rules need to be agreed and compliance
ensured, through agreements with third countries (including the
Association Agreements with the candidate countries), covering
in particular such areas as environmental and nuclear safeguards;
and it intends to identify potential partners.

1.12 The Commission also deals at some length
in its Communication with the development of cross-border trade
within the internal market, which it notes accounts for around
8% of total electricity production, and is increasing, even though
most consumers tend to opt for a national supplier. However, it
considers that, in this respect, the market is far from being
completed, and that, particularly in countries whose market is
dominated by one or two generators, a true market  and
hence effective utilisation of the Community's generating capacity
 can be established only if a high level of imports is
possible. In view of this, the Commission wishes to see action
in three main areas  the adoption of appropriate rules
on the pricing of cross-border trade, rules for the allocation
and management of inter-connection capacity, and an increase in
such capacity, where this is economically justified.

1.13 The Commission also describes the work of
two new bodies  the Florence and Madrid Fora  set
up to deal with these issues in the electricity and gas sectors
respectively, and which meet twice a year to consider them. In
the case of electricity, a major problem has been the adoption
by each Member State of tariffication of cross-border trade on
the basis of their individual national systems, leading to considerable
differences in tariff structures across the Community. The Florence
Forum has therefore sought to address this on the basis of a simple,
transparent, cost-reflective and non-discriminatory approach,
and it agreed in principle in March 2000 that a tariffication
system should be based on physical flows of electricity, with
countries receiving electricity being compensated by the exporting
countries for any costs caused to their networks. It also agreed
that such an approach would be introduced for a provisional test
phase of one year, but with the basis on which any compensation
was paid and received being reflected in national tariff systems,
so long as this did not lead to unreasonable distortion of competition.
However, the Commission says that it does not consider this last
condition can be met on the basis agreed by the Forum, that it
believes a number of important issues (such as the precise methodology
for calculating costs, and the harmonisation of financing methodologies,
and of certain aspects of national tariffication systems) remain
to be resolved, and that it has not therefore been prepared to
endorse this approach. It also says that there is a need to ensure
that the necessary interconnection capacity is in place.

1.14 The Commission has therefore concluded that,
although the Florence Forum has been useful, it has a number of
disadvantages, such as its inability to carry out in-depth discussion,
its informality and reliance on the full consensus of all parties,
and a lack of procedures to ensure implementation. It therefore
considers it necessary to propose a Regulation providing for a
clear decision-making process on the issues surrounding cross-border
exchanges.

1.15 As regards the Madrid Forum for gas, the
Commission says that this is less advanced, due to the fact that
the relevant Directive was implemented 18 months later than that
on electricity, but that the main issues and key principles have
now been identified and a clear agenda for future work set out.
It highlights the higher degree of correlation which exists between
the physical and contract path for gas than for electricity, particularly
as regards international transits, where more than 50% of all
gas consumed within the Community crosses at least one border,
and cross-border tariffs, based on physical flow through the system,
already exist. That said, the Commission warns that this correlation
will be eroded as a result of competition, and that it is vital
to ensure that tariffication systems take account of this fact
and that third party access tariffs reflect costs. It also stresses
the likelihood of congestion becoming a potential barrier to trade.

1.16 The remainder of this part of the Communication
is devoted to infrastructure and the revision of the guidelines
for Trans European Networks (TENs). In the case of electricity,
it points to the tendency in the past for the vertically integrated
public companies to concentrate on the improvement of their own
systems, and hence to the need for remove interconnection bottlenecks
(where it sees the problem being, not so much financial, as political).
The Commission adds that, to overcome these problems, efforts
must be made to upgrade capacity on existing lines, followed by
the construction, where necessary, of new lines through a European
interconnection plan (for which it intends to review existing
capacities and operating standards, as well as the possibilities
for technical improvements, and the minimum need for new connections
between networks).

1.17 In the case of gas, the Commission says
that the sharp increase in demand for natural gas within the Community
over the last ten years has highlighted the need for a well integrated
network, and that generally speaking this is developing well,
with a large number of major new pipeline systems having been
brought into operation. Despite this, it suggests that increased
demand and cross-border trade as a result of market opening may
lead to congestion similar to those already emerging for electricity,
and that consequently, it may be necessary to adopt a similar
approach in identifying new interconnections and establishing
appropriate tariffication and capacity allocation mechanisms.

1.18 The Communication notes that the extension
in 1995 of the TENs programme to cover electricity and gas has
led to the identification of 44 projects in the electricity sector
covering links between Member States and with third countries,
and 46 relating to gas pipelines, thereby contributing to the
achievement of the internal market (and to the reliability and
security of supply). The Commission says that, because the development
of interconnectors between Member States is one of the priorities
of energy transeuropean network policy, it intends to propose
a revision of the relevant guidelines, to stress the goal of the
optimal functioning of such networks in the context of the internal
market for energy.

(b) Proposed Directive

1.19 The key features of the proposed Directive
would be:

 to set dates
of 1 January 2005 for all electricity and gas consumers to have
a choice of suppliers, with intermediate dates of 1 January 2003
for industrial and commercial consumers of electricity and 1 January
2004 for industrial and commercial consumers of gas;

 to require the legal separation of transmission
and distribution systems from the production and supply businesses
in vertically integrated companies;

 to require all Member States to have
independent regulatory authorities for both electricity and gas
markets, with responsibility for the approval of national tariffs
and the terms of access to national networks;

 to require third party access to electricity
and gas transmission and distribution systems, on the basis of
published tariffs approved in advance by the regulatory authority
(with access to gas storage being either regulated or negotiated);

 to require Member States to ensure a
high level of consumer protection, dispute settlement mechanisms,
and transparency of contractual terms: this would include a new
universal service obligation for the supply of electricity, with
an obligation on Member States to report to the Commission every
two years on the measures taken; and

 Member States would also have to ensure
that public service obligations in such areas as environmental
protection were met.

(c) Proposed Regulation

1.20 The proposed Regulation would lay down the
principles to underpin cross-border trading in electricity, covering
charges for access to national transmission networks, the management
of congestion, and the allocation of interconnector capacity.
In essence, the approaches adopted, particularly to charging,
would need to be transparent, non-discriminatory, and to reflect
the actual costs incurred. The Regulation would also set up a
regulatory committee chaired by the Commission and made up of
representatives of the Member States, and one if its tasks would
be to approve, by means of qualified majority voting, binding
Commission guidelines on the detailed procedures for access to
cross-border electricity transmission capacity. The committee
would also advise the Commission in decisions on the amounts of
compensation to be received by transmission system operators for
transit flows of electricity across their system.

The Government's view

1.21 In his Explanatory Memorandum of 28 June
2001, the Minister for Energy and Industry at the Department of
Trade and Industry (Mr Brian Wilson) says that the Government
supports full market-opening in the Community electricity and
gas sectors and is happy with the broad thrust of the proposed
Directive. It regards the provisions on regulated third party
access, independent regulation, and legal separation of transmission
and distribution as particularly important in meeting the aim
of effective competition. He says that the Government agrees that
there is a need for a mechanism to agree cross-border trading
arrangements and to enforce the arrangements agreed, and that
it therefore supports the objectives of the proposed Regulation.
However, he adds that the scope of the Commission's proposal and
its remit in making proposals will need to be considered carefully,
and that it is important that these should be limited to those
issues necessary to facilitate cross-border trading, with national
regulatory systems being left to national regulators to determine.

1.22 The Minister says that, for Great Britain,
the proposals would require minimal adjustment of the existing
regime without imposing additional costs or savings, and will
have a negligible effect of the operation of businesses. In Northern
Ireland, the means and costs of moving to a fully liberalised
market are the subject of a current consultation by the Regulator,
and the position there is as yet unclear.

Conclusion

1.23 Although we note the Government's view
that there would need (at least in Great Britain) to be only minimal
adjustments to the existing arrangements as a result of these
proposals being adopted, this does nevertheless strike us as being
an important document, not least as an indicator of the willingness
of certain other Member States to embrace a high degree of market
openness in these sectors. For that reason, we consider that the
document should be debated, if not in isolation, then at least
alongside the Commission's Green Paper on a strategy for energy
supply, which has already recommended for debate in European Standing
Committee C.[4]
However, in view of the importance here of the views of the other
Member States, we think it would be helpful if, before the debate
takes place, the Minister could set out in a Supplementary Explanatory
Memorandum their reactions to the proposal and the likelihood
of it being adopted in its present form.